Thus far in this series, I’ve shared my thoughts about whether or not you should pay off your mortgage early and whether you should go for a Roth or a Traditional retirement plan. Today I’m going to tackle the topic that most of you really care about around this time of year – how to maximize your tax refund. Last year, the average American received a check for almost $3,000 from the IRS and this year looks to be about the same. Some got $5,000 or even $10,000 and some got even more than that, all at one time, thanks to the federal government’s generosity (ha!). Let’s go through some ways to make sure you’re getting every penny you can and what to do when it shows up.
Don’t Try to Get a Refund
What? Isn’t this about how to maximize your refund? Yes and no. First things first – the reason you get a refund is because you paid too much. This means you gave the government your money and they’re just giving some of it back to you. Think about it. If you get a $3,000 refund, that represents $250 per month of income you could have used each and every month to pay down debt, save for emergencies or retirement, or used for a host of other things. Instead, you get one $3,000 check and are expected to behave with that big chunk of change.
If you’re the average American, you don’t do well with that big lump sum – you go buy something extravagant and are no better off financially than you were when you started. So my advice is this: don’t try to get a refund from the IRS – change your W-4 so less is being withheld, aiming for a very small refund when it is all said and done. You’ll be a lot better off with an extra $250 per month in your budget than you will if I throw $3,000 your way – trust me.
Claim All You Can
While most folks don’t and can’t itemize deductions, that’s actually a good thing. Itemizing means you had lots of expenses! But if it is something you can claim, CLAIM IT! Be honest and be realistic, but millions (probably billions) of dollars in deductible expenses gets left unclaimed every year. Same goes for credits. When I started college, I didn’t realize I could claim the Hope Credit, earning myself $1,800 (at that time) back from the government. By the time I learned about it for that first year of college, it was too late. Did you read that? I let the government keep $1,800 of MY MONEY because I didn’t spend the time and effort to make sure I was claiming everything I could.
Don’t Do Stuff Just For the Sake of Taxes
There are all kinds of things you can do to reduce your tax bill. You can give lots of money to charity, or spend lots of money on job-related expenses, or heck, you could even get a major illness and incur a ton of medical bills. All those things would qualify most of us for a tax bill reduction, but the math never makes sense. This is the argument I made in my post on paying off your mortgage early and it stands true here. If you’re spending money just to save on some taxes, you aren’t winning. Don’t do stuff just to try to lower your tax bill. Claim all you can, but don’t do stuff just so you can claim it!
Make the Most of What You Get
Okay, so by the time you’re reading this, it is probably too late do anything about last year’s withholdings, so what should you do with the big check you’re likely to receive? Let’s keep it simple:
- Save some
- Give some
- Spend some
I really don’t care how you break that down, but the moment you find out how much money is coming, I want you to sit down and have a long, hard look at your financial situation and decide where your priorities are. Then all you have to do is put your money with those priorities. If you’re drowning in debt and relying on credit cards to live your daily life, then you obviously need to pay down some debt and save some money as a buffer against emergencies. If you’re kickin’ tail on your debts and only have a few to go, pay off as many as you can with whatever comes in and then set a little aside for a celebration of knocking out those debts. It is up to you.
Your priorities are different than mine and that’s okay. Just save/give/spend based on what matters to you and decide what matters before the check is in your hand!
What will you do with this year’s refund?